Brazilian state-run oil company Petrobras (NYSE:PBR) is facing a money-laundering probe involving purchases of refineries in the U.S. and Brazil. The allegations, known as Operation "Lava Jato," Portuguese for car wash, revolve around potentially fraudulent transactions between Petrobras and companies involved in the construction of the $20 billion Abreu e Lima Refinery near Recife, Brazil. This amount is several times more than the original budget and it affects contractors Camargo Correa and Sanko Sider, which are also under investigation.
Corruption scandals are not new to the company, but things are getting a bit more complicated now and could mean that this time Petrobras will suffer consequences. Earlier this month, a Brazilian federal court gave police access to Petrobras' bank records as well as the banking records of its former head of refining and fuel supply at Petrobras, Paulo Roberto Costa, and his immediate family. Costa was arrested in March as part of the investigation. If there is a final court sentence affecting Petrobras, its future downstream developments and contract negotiations could be affected. Here's what you need to know.
More to find out
Another probe is looking at $4.52 billion in transactions between Petrobras, a currency broker, several politicians, and Costa in the $1.7 billion purchase of a Pasadena, Texas, refinery. A new parliamentary commission consisting of representatives and senators was specially created to investigate this issue.
What's the impact on Petrobras?
These issues are heating up and Petrobras' image is taking a hit. In fact, the company's offices were raided in March by the police, looking for documents related to Operation Lava Jato.
There are political complexities as well, since the company has close ties with the current administration. President Dilma Rousseff, who is running for reelection in October, was the chairwoman of Petrobras when the Pasadena operation took place. The investments in refineries, offshore oil exploration, and shipyards were key to Rousseff's campaign. Now these components are being put into question.
The Abreu e Lima refinery budget grew almost four times in less than a decade. It handles 230,000 barrels a day, but on a cost per barrel basis it is one of the most expensive refineries ever built. In an industry where capacity and cost efficiency are so important, these deviations could mean two things: mismanagement or corruption.
How's downstream performing?
The expansion of refining capacity remains a challenge for Petrobras, and this goes beyond these scandals. Despite some improvements, the company's downstream sector is still generating losses and will continue to be a drag this year. What's the deal?
Although net losses in the refining, transportation, and marketing segment were 30% lower in 2013, the sector lost almost $8.2 billion. Some initiatives helped, like improvements in domestic prices and the higher feedstock processed in the refineries. Average oil products production reached 2.124 million bpd, up 6% from 2012's output, and the utilization factor moved from 94% in 2012 to 97%.
Improving refining efficiency is important, as it helps Petrobras reduce its diesel and gasoline imports, which are more costly than just crude oil. Petrobras plans to construct nearly 1.5 million barrels a day of refining capacity in the next 10 years, but the new refinery projects are largely behind schedule and over budget, meaning they might never generate sufficient returns on capital. Management might decide to cancel future refinery projects unless returns are met. But the government is involved in future capital allocation decisions, so a scale-back in projects is unlikely. Expanding refining capacity remains one of Rousseff's objectives, and they will push for downstream expansion.
Domestic prices are the big issue here, as they can make refining locally profitable or not. Unfortunately, the company is unable to freely modify prices in accordance to international fuel values. In the end of 2013, though, a new undisclosed pricing policy was put into action, increasing diesel and gasoline prices 8% and 4%, respectively. This ameliorated the situation, along with a 6% growth in domestic sales volumes. However, with inflation picking up in an election year it will be hard to increase prices further.
Construction has historically been used for money laundering, and because of the complexity of the case it will take the Brazilian courts a great deal of time to handle this case. Despite the future trial results, the damage to the company's image has already been done. The final fines and costs related to an unfavorable court sentence are hard to predict, and what seems to be baked into the stock price are the expectations over the presidential elections coming ahead. However, future fines could be a risk.
Investors believe that a change in government could mean less use of state companies as a political instrument, and although Rousseff's popularity has taken a hit, she still remains popular. Her party will do its best to delay the resolution of these issues and to try and separate its figures from the scandal. If justice confirms the allegations in time for the upcoming elections, it could be a catalyst for change. However, this scenario is very unlikely.
The expansion of refining capacity and efficiency is crucial for Petrobras, as it would reduce losses and help the company's financials. But not at any cost. The Brazilian government controls more than 60% of voting power in the company, so these strategic decisions will continue to be heavily influenced even with a change in government.
Louie Grint has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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